Trimming the Fat for Better Growth

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Why do governments need to save? In large part, for some of the same reasons people and firms need to save: to invest and help their economies grow and prosper. Public saving may make up less of national saving than household or corporate saving in Latin America and the Caribbean. But it is nonetheless vital to overall economic health. Greater public saving would allow governments to increase capital expenditures, enhance private sector productivity, and stimulate long-term growth.

Download the book here

Download the book here

Getting there, however, will not be easy. Current public saving rates in the region are on average more than 3 percentage points of GDP lower than in East Asia. Moreover, in recent years they have been falling, dropping from 6% of GDP in 2007 to 2.8% of GDP in 2014 with increases in current expenditures, like salaries, subsidies and social programs. Reversing that trend could be not only economically difficult, it could be politically costly. Voters in the region simply don’t support cuts. That is because expenditure increases, which should have been temporary to help during the financial crisis, now appear to voters as permanent. Expecting them to shrink in the current climate is rather unrealistic. With commodity prices currently depressed, interest rates rising, and many economies suffering, governments are likely to find little support for the traditional means of boosting public saving: spending cuts and higher taxes.

Fortunately, governments have other options. Rather than cutting public expenditures across the board, they can engage in “smart” adjustments. That is, they can dissect the budget and attack inefficiencies. One place to start is with those expenditures involving subsidies originally intended to help the poor that are badly targeted and end up subsidizing the well-to-do and rich. Take energy subsidies. A country may have an electricity subsidy for consumption on the first 150 KWh intended to help families that are struggling to pay their bills. But this invariably helps all households with their first 150 KWh, constituting a wasteful use of resources, or leakage, beyond the targeted population. If more precise targeting polices were implemented to this and other forms of energy like gasoline, natural gas, and fuel oil, governments could obtain savings of more than 1% of GDP, given that currently two-thirds of energy subsidies leak out to non-poor households.

Savings can also be obtained from better targeting of conditional cash transfers and non-contributory pensions. Such programs help reduce poverty and inequality. Spending on them has increased, even tripling in some countries between 2003-2013. But because of improper targeting they also end up subsidizing people who don’t need the programs, costing the region 0.5% of its GDP. Reductions on tax expenditures with a social component, such as exemptions to the value added tax (VAT) or exemptions for food, medicine and rent, meanwhile, lead to even greater losses — about 07% of GDP on average, but as much as 2% of GDP in some countries−with nearly three quarters of reductions benefitting non-poor households.

Education and health expenditures should also be revisited, especially by looking at cases where the numbers of workers are excessive and wages exceed productivity. The challenge, however, is great: these areas involve universal programs intended to benefit all sectors of the population, rather than just the poor. But different methodologies can be used to look for inefficiencies. One might, for example, use countries that are highly efficient as a benchmark against which other countries can be measured. South Korea, for example, is a useful benchmark for education, given its high test scores and relatively low number of teachers per student. Excessive teacher salaries for a given level of development can also be part of the problem. Savings in both dimensions could account on average to 0.7% of GDP in education, and 0.2% of GDP in health, with wide variations across countries in the region.

Although politically difficult, it can’t begin soon enough. The public sector needs to lose weight to remain sustainable. Between 2007-2014, total government expenditure in the region jumped 3.7 percentage points of GDP with more than 90% of that going to current expenditures, and only 8% to public investment, or saving. That means money isn’t being set aside for badly needed infrastructure spending. Such spending, as a percentage of GDP, significantly lags other developing regions like Asia and has resulted in substandard roads, ports, and airports. It means that savings are woefully inadequate for that time later in the century when the number of non-working dependents will almost equal that of the working and the demand for health services and pensions will soar. Adding it all up, savings from tackling inefficiencies in energy, social programs, tax expenditures, health and education could amount to around 3% of GDP. Reducing such inefficiencies will not only help ensure fiscal solvency. It will allow for productive investments that are critical to putting the region on a sustainable path with higher growth.

Some of these issues are discussed in the 2016 edition of the IDB’s flagship series, Development in the Americas, entitled Saving for Development: How Latin America and the Caribbean Can Save More and Better. Click here to download the book.

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The Author

Alejandro Izquierdo

Alejandro Izquierdo

Alejandro Izquierdo is currently a Principal Economist at the Research Department of the Inter-American Development Bank. Previously he worked at the World Bank in the Department of Economic Policy, and taught courses on macroeconomics and international finance at several Latin American universities. He holds a Ph.D. in Economics from the University of Maryland, an M.S. from Instituto Torcuato Di Tella, Argentina, and a B.A. in Economics from Universidad de Buenos Aires, Argentina. Alejandro has several publications in professional journals and edited volumes. His current research interests include issues in international finance such as the role of external factors on growth, the relevance of balance-sheet effects and financial integration in determining the likelihood of experiencing Sudden Stops in capital flows, as well as how countries recover from output collapses following Sudden Stops. He has also worked on the impact of Sudden Stops in the variance of relative prices, fiscal sustainability under Sudden Stops, and amplification effects of collateral constraints on the real exchange rate and output. Additionally, he has conducted research on the impact of macroeconomic external shocks and public expenditure allocation on poverty reduction for developing countries using computable general equilibrium models.
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